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What are the benefits of a trade credit?

We are dealing here with the consent of the seller to receive payment for the delivered goods (or service rendered) after the delivery date.

The granting of trade credit may be confirmed by a contract concluded between the parties, general conditions of sale or may result only from the payment date specified on the invoice. It does not require any special legal form.

It is a beneficial alternative to loans granted by credit institutions. Loans granted by banks are usually conditioned by carrying out a complicated procedure that requires the borrower to meet many conditions. Trade credit eliminates the banking path and enables crediting of trade between contractors.

Trade credit – advantages

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Trade credit is also competitive for bank loans due to costs. It is referred to as the cheapest loan because thanks to it the buyer has the option of selling the goods even before the payment date, and thus does not have to engage their own funds for this period or run revolving loans.

Therefore, it may for some time have other people’s resources at its disposal or create a reserve fund, guaranteeing that payment deadlines are met and, as a result, maintaining liquidity.

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Recognizing it as the cheapest loan depends, however, on the use of the discount institution (rebate) together. Used without the support of this instrument, it may not be too cheap, but not complicated, and therefore attractive and quick to obtain.

In legal terms, trade credit is a special type of credit, where the partners are business entities that are not financing institutions.

A regular sale/purchase transaction will change into a trade credit if the transaction partners agree to defer payment. The number of days between the release of a good or the provision of a service and the payment deadline is called the credit time.

Supplier’s market and recipient’s market

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Trade credit operates in some industries independently, without the support of additional financial instruments. This means that the manufacturer sets the payment rules without negotiation, and the recipient has the choice to join or not to enter into such a contract.

In such cases, the producer treats his position on the market authoritatively and does not use additional incentives to acquire the recipient. This is the supplier’s market.

The reverse situation is one in which the recipient of the goods has the advantage and he dictates the terms of payment. This so-called recipient market. Markets with a predominance of customers or suppliers are a sign of economic imbalance. Then no one needs to use additional support, because his position does not require it.

The main burden of trade in the world takes place in conditions of balanced demand and supply, and then additional incentives are needed to use forms of financial support such as trade credit.

Discount and deferred payment

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One of the main instruments used together with trade credit is a discount. This is a percentage reduction in the price the recipient receives if he pays for the goods immediately upon receipt.

In practice, this boils down to the recipient’s choice of one of two variants; or immediate payment in cash or in another form (e.g. check) and the benefit of a rebate, or definitely a trade credit, which is a deferred payment in which the rebate is no longer present.
Of course, obtaining a discount is not only the recipient’s decision, because his position in the legal relationship, characteristic of trade credit, is identical to the position of the debtor, the condition for obtaining this option is always the creditor’s decision. It is he who tests the credibility of the recipient and sets the rules for granting trade credit.

If such a decision is initially made, then only the recipient has the option of a discount or deferred payment. This does not apply if the recipient is not interested in deferred payments, but only in cash, in which the discount is generally granted.

Trade credit – seller’s risk

Trade credit - seller

The seller is a party that bears a very high risk of a trade credit agreement. That is why, in practice, this loan is granted to companies that you have full confidence and have their basis in a long-term cooperation. The trade-credit is intended for customers who I have no doubt will fulfill their obligations and will pay within a specified period.

The seller who counts on the possibility of granting trade credit to the buyer must consider taking the risk. Customers without proven credibility are treated with a high degree of caution – at the beginning of cooperation they cannot count on receiving deferred payments, and only after some time they can apply for them.

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There is a possibility of additional deferred payment security, which allows us to overcome the fear of unreliability in loan repayment. The seller may request the buyer to provide adequate security, in the form of a contract for the calculation of penalty default interest, a blank promissory note, surety, pledge or bank guarantee.

Trade credit collateral

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Trade credit collateral is not only measures taken to guarantee repayment of deferred payments. Overdue payments are a serious problem in the economy, and effective debt collection is often a prerequisite for maintaining the company’s existence in the market.

However, it is possible that all deferred payments are paid on time, but the amount of trade credits granted significantly improves the company’s financial liquidity.

Despite the lack of congestion caused by late repayment, there is a “hunger” for funds in the company’s finances. In such cases, factoring as a safe supplement to the trade credit is a supporting instrument.

It helps in the exchange of overdue receivables for cash, thanks to which problems with the current settlement of liabilities disappear and in this way the company’s balance sheet improves. 

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